The Changing Face Of REITs

Real estate investment trusts - or REITs - were first introduced to the UK in 2007. Initially, they could only be established with commercial properties. But earlier this year, that all started to change...

Real estate investment trusts - or REITs - were first introduced to the UK in 2007. Initially, they could only be established with commercial properties. But earlier this year, that all started to change with the chancellor's announcement that the REITs market is to be opened up to include residential assets. George Osborne announced the proposals under the reform of Stamp Duty Land Tax (SDLT), altering the amount of SDLT charged on purchases of multiple dwellings by calculating the fee based on the average value of the properties bought, rather than the aggregate value as is currently the case.

These changes to SDLT remove one of the barriers to REITs based on residential assets, head of real estate research at Espirito Santo Michael Burt noted in an article for Property Week, following the chancellor's budget speech. He stated that the removal of the flat four per cent charge on bulk purchases "creates the real possibility that pure residential REITs will emerge".

But Mr Osborne announced further proposals for REITs that are due to come into force with the 2012 Finance Bill. One of these is the abolition of the two per cent conversion charge levied on all REITs when they are established. A report by KPMG examining proposals commented that this step is likely to make the trusts "significantly more attractive" to investors.

Another important alteration to the regime is the planned introduction of a "diverse ownership rule for institutional investors". Currently, REITs must have a wide shareholder base - generally speaking, they must be controlled by five or more people. The current regulations make it difficult for pension funds and insurance firms to own REITs because they are considered to be 'close companies', even though they in fact have a diverse ownership.

The KPMG report explained that allowing residential property REITs in the UK will open up a number of opportunities, both to investors and other companies. The organisation cited house builders as one group that may want to consider establishing a REIT with portfolios of dwellings, while large-scale residential landlords may also be able to benefit from the changes to the rules.

So, what exactly makes REITs attractive to investors? One of the main advantages of them is that they offer a way in which to invest in property without having to worry about the management and maintenance of the asset. They also remove the need to acquire a mortgage in order to make the initial investment, which may aid their market appeal.

REITs predominantly generate their funds from rental income on the properties in their portfolios, with 90 per cent of this having to be passed on to shareholders. The British Property Federation (BPF) points out that REITs are often a more volatile investment option than dealing directly with the real estate assets, adding that in some ways they perform more like equities than property. However, the organisation adds that, in the long term, they more closely follow the latter.

Chief executive of the BPF Liz Peace welcomed the introduction of REITs based on housing rather than commercial assets, commenting: "Most of the ingredients for institutional investment in residential property are already in place." She stressed that returns for private landlords in the UK are good and that opening the market up to include REITs is a sensible step, because the "traditional build to purchase and buy-to-let house building model is simply not delivering enough homes to meet the UK's future needs".

There is the argument that house prices have been artificially inflated by opening the residential sector up for institutional investors, but this model has its advantages too. KPMG suggested that social house builders could make particularly good use of REITs to raise capital from their portfolios that can then be ploughed into new construction projects. And the BPF is certainly positive about the future of UK REITs, stating that these reforms will help boost investment in the country's property industry as a whole, in addition to having an impact on the "scale and health" of the REITs sector.

- Monday 22 August 2011

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